This week we asked Aditya Pattanaik, Investment Advisor at Sprott Global, to share with us how the recent market volatility rate has affected the price of gold. He also talked to Evrim’s CEO Paddy Nicol about how gold exploration has been affected by social distancing guidelines.
Guest post by: Aditya Pattanaik, Investment Advisor at Sprott Global
March 2020 will be a month to remember. Disruptive events change a lot of things but do eventually pass. It will be interesting to see what the new normal looks like, when it does. For U.S. financial markets, March marked the end of the longest expansion in U.S. history. The velocity of the reversal was giddying. The fiscal and monetary response to the crises was equally stirring. Some argue that COVID-19 was merely a pin that pricked a global credit bubble, and will mark the start of a protracted global economic downturn. Others contend that the recovery will be fast and furious, once life returns to normal. I believe that this is the beginning of a period of unravelling of the excesses of an unsustainable credit-fueled economic expansion, despite the unprecedented levels of quantitative easing (QE). Living beyond your means, always ends badly.
For investors, the uncertainty in the equity markets and the near zero interest rates offered by Treasury markets has also sparked off a renewed interest in alternative assets like gold. Gold is now at seven-year highs. Gold miners have been in a long bear market since 2012, are also beginning to show signs of life again. In this article, we juxtapose the supply and demand dynamics for gold under the prevailing macro-economic backdrop.
Chart 1: Performance of Equities, Treasuries, Gold, Commodities, Source: Factset
ON THE DEMAND SIDE
Over the past several years, many contrarian market observers underscored the data that warned of an inevitable and dramatic reversion of the longest economic expansion in U.S. history. The pandemic-fueled global shut-down of industries across the world is now compounding the effects of an over-leveraged and debt-ridden expansion.
The volatility over the past month is best captured in a series of charts that illustrate the trading activity of equities, treasuries and gold over this period. Oil prices crashed too, as OPEC+ members clashed over production cuts in response to weakening demand. The speed of the market selloff was noteworthy as was the heightened pace of the policy response. The quarter ended as one of the worst quarters, over a 30-year period.
Chart 2 : The Market Volatility in March ( Stock ), Source: Dow Jones Market data, Factset
Chart 3 : The Market Volatility in March ( Treasuries ), Source: Tullett Prebon
Chart 4 : The Market Volatility in March ( Oil ), Source: Dow Jones Market data, Factset
Gold is considered a safe haven asset because of its negative correlation to the market. In the month that passed, a stampede for liquidity sparked a frenzied sell-off in all asset classes that got a bid, including gold. The case for gold as a long term store of value is applicable not in a liquidity crisis, but in the circumstances that arise after, as a consequence of the policy response to a crisis.
Chart 5 : The Fed Policy response, Source: Congressional budget office, Board of Governors
The deflation of over-leveraged financial assets, zero interest rates, and the devaluation of currencies by unprecedented levels of QE are circumstances that will likely create a very strong demand for gold. The price of gold, as I write this article, is now close to seven years highs and is already reflecting a strong renewed demand for this alternative asset class.
ON THE SUPPLY SIDE
Commodities are well known to be deeply cyclical, with price-margin cycles that lead to imbalances in supply and demand on a predictable basis, over the long term. The recent collapse in the oil markets was a stark reminder of this cyclicality. While it is extremely difficult to time the peaks and troughs of these cycles with much precision, it is possible to infer trends in a broader directional sense.
Gold mining has seen a strong decline in the number of the new discoveries over the last decade. This has been a function of both a decrease in investment in exploration and an increase in its complexity as a result of the need to look deeper and in more remote places. Trends in exploration point to an overall decrease in the replacement of existing mineable resource levels. The increased M&A activity over the past year especially amongst the majors underscores this trend.
I recently interviewed the CEO of a mineral exploration company about these trends. They own projects in Canada and Mexico and I was interested in particular about how exploration activity levels have been affected by COVID-19. He confirmed that travel, fieldwork, site visits and operational activity have been temporarily halted following health and safety guidelines set by the company as well as the jurisdictions where they operate. They had completed extensive generative work in the first two months of the year so desktop reviews of new data collected in the field is ongoing. They have also signed a number of CA’s with interested groups, who are currently reviewing their data on a number of projects. What stood out was a point made on the increase in the number of enquiries about their gold properties.
Chart 6: Trends in Exploration, Source: SNL Metals & Mining
For an investor, it is important to pay attention to the effects of long-term price-margin cycles on the supply demand dynamics. I believe that we at the early stages of an uptrend in the precious metals based on macro-economic factors, which will eventually lead to renewed investment in the supply side of the equation via exploration companies. For investors – there is a strong case now to be invested in these companies, based on both supply and demand dynamics.
Chart 7: Barron’s Gold Miners Index (1970-2020), Source: Goldchartrus.com
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